The Data Century

The 20th century introduced the “Atomic Age.” With the 21st be the “Data Century?”

Source: Wikipedia

The 20th century arguably began, conceptually, when Albert Einstein published his seminal paper on special relativity. The intellectual upheaval this initiated ultimately led to the expression E = mc2, nuclear energy, and the atomic bomb. Atomic weapons and nuclear power revolutionized war, diplomacy, geopolitics, and—to a lesser extent—electricity generation. Although a nuclear reaction is still a pretty inefficient way to boil water.

The 21st century began with the dot-com boom and bust, and the proliferation of data networks, data mining, data analysis, and data storage. “Big Data” is the term we use for data sets too large and complex for traditional data management approaches. There are now more than 1 trillion websites with more than 10 trillion individual web pages, with more than 500 exabytes of data. (An exabyte is 1 million terabytes.) And the data keep growing exponentially.

Author: Hilbert, M., Science: 332(6025): 60-65. Source: Wikipedia

The complexity can boggle our minds, in the same way that the implications of relativity did a hundred years ago: time doesn’t proceed at a uniform pace across the universe, light bends around large mass objects, and the universe’s mass-energy is gradually running down. But while the atomic age gave us immensely powerful weapons, it was still governed by rather prosaic rules of governing: the military must be subordinate to civilian authority, war is an extension of diplomacy, and so on. Nuclear power didn’t fundamentally change human nature.

Likewise, the rules of big data still have to follow the rules of “little data”: correlation does not equal causation, bad data leads to bad conclusions, and there’s always more data to collect, among others. Just because we have more information doesn’t mean our thinking is any better. Indeed, one of the most important axioms of data modelling is that accuracy is more important than precision.

Still, there’s a lot of new material out there. We can now use satellite images to gauge industrial activity in remote locations, we can screen-scrape a billion prices per day to estimate inflation around the world, we can look at lending and borrowing activity in real-time. This has the potential to make our economic analysis and investment decisions far more efficient.

Just don’t expect a revolution. “Big Data” may allow us to be more informed, but it won’t make us any smarter.

Douglas Tengdin, CFA

Charter Trust Company

The Law of the Jungle?

Croplands are monocultures. Jungles are diverse. Which is better?

Photo: M. Connors. Source: Morguefile

It depends on what you want. If you’re looking to get as much food as possible with the least energy input, then you want managed fields. On the other hand, if you’re looking for new types of plants that can survive the stresses and strains of nature, then you want a diverse wilderness.

I thought about this while considering China’s state-managed capitalism in comparison to America’s entrepreneurial system. There is no question that China emerged first from the global recession with their massive state spending. And by importing machinery from Germany and coal from Australia, they helped pull those economies out of the downturn as well. As some observers have noted, there’s a certain appeal to this: the country’s leaders can just say “go” and everything takes off.

Photo: Justin Russel. Source: Wikipedia

But there is a downside to this kind of management. Such economies do fine when it comes to implementing established processes. But to develop totally new ideas, you want a network of innovative trailblazers who can envision a reality that doesn’t even exist yet. Consider the Kindle or the iPad. Before Apple or Amazon came out with their blockbuster products, e-readers and tablet computers were curiosities. Now they’ve transformed publishing and home computing. And China’s transition from export-powerhouse to consumer-driven service economy isn’t going as quickly as its leaders hoped.

Managed systems are productive but brittle. A major change in conditions can destroy a whole crop, or much of an economy. Diverse systems are confusing but highly productive in their own way: a lot goes on in the jungle. And they react to disruptions quickly. When it comes to economics, our diversity really is our strength.

Douglas Tengdin, CFA

Charter Trust Company

The Tyranny of Science?

Is technology all that matters?

Photo: Giedre Raminate. Source: Refe

I’m an advocate and science and engineering. I was a science major in college. Three of my children are engineers. I have family members who design rockets and power systems. But I’m a little uncomfortable with the exclusive emphasis on science and math these days. Radio stations have special STEM reports to discuss trends in education. When a college has to shut down a department, it’s usually something like literature or Latin—rarely physics or chemistry.

Even more disturbing is the assertion by policy advocates that their recommendations will be based on “pure science.” But there’s nothing pure about science. Science just describes what scientists do, and scientists are people with interests and agendas like the rest of us. Over 230 years ago Immanuel Kant explained that we never really know what is objectively out there. Rather, we creatively project order onto the “brute facts” in order to give them meaning. “The intellect does not derive its laws from nature,” he writes, “but prescribes them to nature.”

We shouldn’t be surprised, then, when we learn of scientists who fabricate results or plagiarize or “discover” truths in line with the political agendas of their funding sources. Where you stand usually depends on where you sit. Some of the most important science—that rarely gets noted—consists of trying to replicate previously published research. Notable scientific frauds like cold fusion and water memory were debunked in this way.

Nevertheless, there is an objective reality out there, and humanity has made tremendous progress by understanding how nature works. Advances in agriculture, for example, have reduced famine and starvation around the world. But science at best advances our knowledge. It doesn’t tell us what to do with it.

The best examples of science in everyday life combine technological competence with style and elegance: the Eiffel Tower, a Lamborghini Miura, Apple’s original iPod. In these we see form and function combine to give us a delightful sense of aesthetic pleasure. But you won’t learn about design and aesthetics in chemical engineering classes.

1967 Lamborghini Miura. Photo Michael Barera. Source: Wikipedia

That’s why our education needs to be liberal as well as technical. The future doesn’t just belong to data scientists and A/B testing, important as these may be. Because not everything that counts can be counted, and not everything that can be counted counts.

Douglas Tengdin, CFA

Charter Trust Company

Rabbits, Ducks, and Markets

Is it a bull market or a bear market?

Source: Wikipedia

It all depends on your perspective. Like the famous rabbit-duck illusion. People who want to see a rabbit see long ears, a split nose, and a soft face. Folks who want to see a duck see a split bill, a tongue, and a bright eye. There’s no clear answer.

The same thing could be said about the market right now. Those who want to see a bull market point to a growing economy, falling unemployment, and rising inflation. Industrial prices bottomed in November of last year. Since then, commodity prices are up 10%, led by metals, which are up almost 20%. Rising inflation should keep the deflationary demons at bay that plague the rest of the world right now.

Those who want to see a bear market point to falling corporate profits, a strong dollar depressing US exports, and a Fed that continues to state that they want to “normalize” interest rates, by which they mean they want to raise rates—and you don’t want to fight the Fed. The market is in a pickle: if the economy strengthens, the Fed will raise rates more quickly. If it weakens, profits will fall further. In either case, it’s hard for the market to grow when earnings fall.

S&P 500 iShares. Source: Finviz

And the charts aren’t much help. The trend is supposed to be our friend, and we’re in a long-term up-trend that began March of 2009—seven years ago. But the market topped out in July of last year. Since then we’ve seen two pullbacks of at least 10%, with lower highs and lower lows. These declines are supposed to be healthy for a bull market—keeping the “weak hands” out, and avoiding speculative excess. But they also spark a lot of fear.

So by some measures the market looks fine, and by some it looks worrisome. This is often the case—we see what we want to see. Eventually, reality comes home. It’s still unclear where the chickens will roost.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Gift of Failure

Many people talk about the successes of the market. But what it really allows is failure.

Photo: Dodgerton Skillhause. Source: Morguefile

Centuries ago, if you couldn’t pay your bills, you went to debtor’s prison where you rotted until you could get someone to bail you out. In ancient Rome, if you pledged yourself as collateral and couldn’t pay your loan you would become your lender’s slave. Colonial Virginia was settled by thousands of indentured (i.e. indebted) servants paying off their debts with their labor.

In the US we abolished debtor’s prisons by the mid-1800s. Some notable people had been imprisoned, including Light-Horse Harry Lee, a Colonel in the Revolutionary War and Governor of Virginia. We replaced prison with bankruptcy, a way to start over.

This came to mind as I thought about Puerto Rico, Federal bankruptcy laws, and Uber. In San Francisco earlier this month, the city’s biggest cab company has filed to restructure its business. San Francisco is the birthplace of Uber. Traditional taxi services have been struggling as the ride-sharing service has gained market share. It turns out that people like calling for a cab with an app on their smart-phones. The San Francisco cab company couldn’t compete—it had lost too many riders and drivers.

Photo: Dan Tada. Source: Morguefile

This is what some have called “creative destruction.” Commercial structures are disrupted from within, as new patterns and processes of economic life evolve. In this case, people make choices that are cheaper or more convenient to them, and a monopolistic business has to make way for a more competitive alternative. By allowing the taxis to fail, consumers win. And the assets and drivers of the cab company go somewhere else.

In these days of too-big-to-fail banks, territories, and hospital systems, it’s important to remember: we can either learn from our failures, or send them to prison.

Douglas R. Tengdin, CFA

Chief Investment Officer

Moving Out?

Has America’s economy become less mobile?

Photo: Dwight Burdette. Source: Wikipedia

Labor market mobility in the US has declined. It used to be that when an area was depressed, people moved to where there were better opportunities. But following the financial crisis, more folks stayed put and simply dropped out of the labor force—either retiring or going on disability. This has broad implications for wages, productivity, and overall economic growth.

Migration across state lines from areas of high joblessness to areas of low unemployment helps equalize wages rates and employment opportunity. Some places may be harder hit than others, but our mobility has made the US into one large labor market. I myself have changed the state where I live several times when I needed to move to take a new a job. And it was always to a better situation.

But there is evidence that the rate of interstate and intra-state migration has fallen. This trend didn’t start with the financial crisis, but the dramatic decline in housing prices didn’t help. Since at least the ‘80s, workers have been less willing to pull up stakes and relocate. It’s not just that there are fewer young people in the workforce, or that it’s harder to move when both spouses have jobs, or that regulatory burdens associated with hiring and firing have increased, or that people just don’t trust strangers as much anymore. It’s like a combination of factors—some demographic, some regulatory, some cultural—that have pushed labor market mobility downwards.

Source: Brookings

Whatever the cause, this has an effect on productivity and profits. If fewer people are willing to move to where there are jobs, this means some areas of the country will suffer longer downturns, while others could see labor shortages. During the oil boom, convenience-store clerks in North Dakota could earn $24 / hour. But there weren’t as many folks willing to put up with their harsh winters. This means 7-11s in Williston weren’t very profitable.

This is important. If companies can’t make money, they’re not willing to hire new workers. Low mobility could lead, then, to a less dynamic labor market. If we want to get back to a growing economy, we’d better make sure businesses can hire the people that will help them grow.

Douglas R. Tengdin, CFA

Chief Investment Officer

Stop It!

What should investors stop doing?

Photo: Kevin Connors. Source: Morguefile

Often, improving performance is a matter of ending bad habits. This is true in many areas of our lives. If we want to have better relationships, then it’s a good idea to stop avoiding difficult conversations. If we want to have better personal finances, we should stop buying major items without a plan. If we want to be better tennis players, we should stop jumping when hitting the ball.

So here is a list of bad investment habits. Any one of these could be a performance-killer.

Stop focusing on your cost-basis. The only reason to worry about where you bought an investment is when you’re figuring out your taxes. A stock doesn’t know you own it, and it certainly doesn’t care where you bought it.

Stop chasing the latest hot investing idea. Hot trends come and go. When they’re hot is often when they’re the most overpriced. Often they’re just marketing buzz-words. But even sound investment strategies fall in and out of favor.

Stop trading excessively. The market may offer nonstop action, but that action won’t necessarily help your portfolio. Excessive trading not only generates more transactional costs, it also increases the chances of chasing a hot trend.

Stop ignoring risk. A stock may be up a lot, but if the underlying company doesn’t have any earnings, it’s not going to stay that way. Similarly, bonds may be boring, but if they help you meet your needs, then boring can be beautiful.

Source: Lewis Capital Management

Stop worrying about everyone else. It doesn’t really matter if your neighbor made a pile on some biotech wonder or a social networking stock. What matters if whether your portfolio is on-track to satisfy your financial needs.

Finally, stop ignoring why. We focus too much on the what of investing—what stocks to buy, what asset allocation to have, what our investment return is. But we ignore the why—why are we investing, why do we have this money set aside in the first place. What questions engage us—why questions challenge us. Maybe that’s why we avoid them.

Replacing bad habits with good habits isn’t easy. Habits are unconscious patterns of behavior and thinking that occur again and again. It’s our habits that make us who we are. Good habits—and good investments—don’t happen by accident. They take disciplined, careful focus. Fixing mistakes isn’t very exciting or make great cocktail party chatter. But it’s a sure way to improve. And isn’t that why we’re invested in the first place?

Douglas R. Tengdin, CFA

Chief Investment Officer

Balancing Act (Part 2)

How can investors use both sides of the balance sheet?

Photo: Canibek. Source: Morguefile

Balance sheets are basic. They usually go from the most simple things to the most complex. The asset side starts with cash, moves through inventory, then fixed assets, like property and factories, and ends up with intangibles: goodwill, trademarks, patents. It’s easy to measure the value of cash or liquid investments. It gets more and more difficult to put a price on something as you move down the page. What’s the value of a brand, anyway?

The same is true on the other side. Liabilities start with payables, short-term debt, long-term debt, and then equity—what’s left over. There’s a reason why we start at the top and move down: if the creditors walk away, refusing to renew credit lines or short-term loans, there needs to be enough cash on hand to pay them off. A balance sheet that’s out of whack–where there aren’t enough current assets to fund current liabilities—is a balance sheet that’s dangerous.

The balance sheet works with the other financials to give a total picture, but it’s the balance sheet we start with. Another way to look at the balance sheet is to normalize everything. Assume that the assets and liabilities each add up to $100, and each line item is just part of that total. It’s easier, then, to see changes in the balance sheet’s structure over time. If something shifts significantly—say, inventory is rising, or the value of equipment and property is going down—then it indicates that something significant may be going on at the company. And on the liability side, if long-term loans are going down while accounts payable are rising … maybe you have a liquidity crisis coming!

ECB Assets over time. Source: Wikipedia

The balance sheet is a start. It gives us snapshot of a company’s financial health. And looking at how it changes over time gives a fuller picture of what’s going on. Reading a balance sheet is like reading a map. If we want to know where we’re going, we’d better start out by figuring out where we are.

Douglas R. Tengdin, CFA

Chief Investment Officer

Opening Up (Part 1)

Investors need to use both sides of their brains.

Photo: Unsplash

Yes, there’s the analytic side and the intuitive side. There’s numerical number-crunching and there’s aha-moment insight, the kind that gets into Apple at 30 and out of Amazon at 650. But that’s not the two-sidedness that I’m talking about.

I mean the balance sheet. Yes, that boring, accounting-level statement of what a business owns and owes. The statement of cash, receivables, inventory, property and equipment on one side, and payables, short-term loans, long-term loans, and equity on the other side: assets and liabilities—both sides.

For a long time the balance sheet was the Rodney Dangerfield of accounting: it didn’t get no respect. After the dot-com bust and Enron scandals analysts focused on earnings and cash-flow, respectively. But it took the financial crisis to raise the prospects of the balance sheet.

The balance sheet gives you an inside picture of a company’s financial health. Assets—and especially liquid assets—indicate how well they can deal with stress. And liabilities, particularly short-term borrowings, show where that stress might come from. When short-term loans are too high relative to cash and other liquid assets, creditors can shut down a company by just walking away. During the Depression some banks had three-quarters of their assets in cash, not because they were sick, but because they were healthy, and wanted to stay that way.

The truth is, all three accounting statements are important: earnings, cash-flow, and the balance sheet. In combination, and over time, they show what’s going on inside. But it’s the balance sheet that shows when things are out of balance.

Douglas R. Tengdin, CFA

Chief Investment Officer